15. Financial instruments and fair value

Signet’s principal financial instruments are comprised of cash, cash deposits/investments and overdrafts, accounts receivable and payable, derivatives, US Treasury and government agency securities, corporate bonds, notes and equity securities, a revolving credit facility and long-term debt. Signet does not enter into derivative transactions for trading purposes. Derivative transactions are used by Signet for risk management purposes to address risks inherent in Signet’s business operations and sources of financing. The main risks arising from Signet’s operations are market risk including foreign currency risk and commodity risk, liquidity risk and interest rate risk. Signet uses these financial instruments to manage and mitigate these risks under policies reviewed and approved by the Board of Directors.

Market risk

Signet generates revenues and incurs expenses in US dollars, Canadian dollars and British pounds. As a portion of the UK Jewelry purchases and the purchases made by the Canadian operations of the Zale division are denominated in US dollars, Signet enters into forward foreign currency exchange contracts, foreign currency option contracts and foreign currency swaps to manage this exposure to the US dollar.

Signet holds a fluctuating amount of British pounds reflecting the cash generative characteristics of the UK Jewelry division. Signet’s objective is to minimize net foreign exchange exposure to the income statement on British pound denominated items through managing this level of cash, British pound denominated intercompany balances and US dollar to British pound swaps. In order to manage the foreign exchange exposure and minimize the level of British pound cash held by Signet, the British pound denominated subsidiaries pay dividends regularly to their immediate holding companies and excess British pounds are sold in exchange for US dollars.

Signet’s policy is to minimize the impact of precious metal commodity price volatility on operating results through the use of outright forward purchases of, or by entering into options to purchase, precious metals within treasury guidelines approved by the Board of Directors. In particular, Signet undertakes some hedging of its requirements for gold through the use of options, net zero-cost collar arrangements (a combination of call and put option contracts), forward contracts and commodity purchasing, while fluctuations in the cost of diamonds are not hedged.

Liquidity risk

Signet’s objective is to ensure that it has access to, or the ability to generate sufficient cash from either internal or external sources in a timely and cost-effective manner to meet its commitments as they become due and payable. Signet manages liquidity risks as part of its overall risk management policy. Management produces forecasting and budgeting information that is reviewed and monitored by the Board of Directors. Cash generated from operations and external financing are the main sources of funding supplementing Signet’s resources in meeting liquidity requirements.

The main external sources of funding are an amended credit facility, senior unsecured notes and securitized credit card receivables, as described in Note 19.

Interest rate risk

Signet may enter into various interest rate protection agreements in order to limit the impact of movements in interest rates on its cash or borrowings. There were no interest rate protection agreements outstanding at November 1, 2014, February 1, 2014 or November 2, 2013. See Note 19 for additional information regarding loans and long-term debt.

Credit risk and concentrations of credit risk

Credit risk represents the loss that would be recognized at the reporting date if counterparties failed to perform as contracted. Signet does not anticipate non-performance by counterparties of its financial instruments, except for customer in-house financing receivables as disclosed in Note 8 of which no single customer represents a significant portion of the Company’s receivable balance. Signet does not require collateral or other security to support cash investments or financial instruments with credit risk; however, it is Signet’s policy to only hold cash and cash equivalent investments and to transact financial instruments with financial institutions with a certain minimum credit rating. Management does not believe Signet is exposed to any significant concentrations of credit risk that arise from cash and cash equivalent investments, derivatives or accounts receivable.

Derivatives

The following types of derivative instruments are utilized by Signet:

Forward foreign currency exchange contracts (designated) — These contracts, which are principally in US dollars, are entered into in order to limit the impact of movements in foreign exchange rates on forecasted foreign currency purchases. The total notional amount of these foreign currency contracts outstanding as of November 1, 2014 was $27.4 million (February 1, 2014 and November 2, 2013: $42.3 million and $60.4 million, respectively). These contracts have been designated as cash flow hedges and will be settled over the next 9 months (February 1, 2014 and November 2, 2013: 12 months and 15 months, respectively).

Forward foreign currency exchange contracts (undesignated) — Foreign currency contracts not designated as cash flow hedges are used to hedge currency flows through Signet’s bank accounts to mitigate Signet’s exposure to foreign currency exchange risk in its cash and borrowings. The total notional amount of these foreign currency contracts outstanding as of November 1, 2014 was $58.4 million (February 1, 2014 and November 2, 2013: $22.1 million and $103.4 million, respectively).

Commodity forward purchase contracts and net zero-cost collar arrangements (designated) — These contracts are entered into in order to reduce Signet’s exposure to significant movements in the price of the underlying precious metal raw material. The total notional amount of these commodity derivative contracts outstanding as of November 1, 2014 was $85.4 million (February 1, 2014 and November 2, 2013: $63.0 million and $58.1 million, respectively). These contracts have been designated as cash flow hedges and will be settled over the next 12 months (February 1, 2014 and November 2, 2013: 12 months and 12 months, respectively).

The bank counterparties to the derivative instruments expose Signet to credit-related losses in the event of their non-performance. However, to mitigate that risk, Signet only contracts with counterparties that meet certain minimum requirements under its counterparty risk assessment process. As of November 1, 2014, Signet believes that this credit risk did not materially change the fair value of the foreign currency or commodity contracts.

The following table summarizes the fair value and presentation of derivative instruments in the condensed consolidated balance sheets:


	Derivative assets
			Fair value
(in millions)	Balance sheet location		November 1, 2014			February 1, 2014			November 2, 2013
Derivatives designated as hedging instruments:
Foreign currency contracts		Other current assets	$	0.4		$	—		$	0.2
Foreign currency contracts		Other assets		—			—			—
Commodity contracts		Other current assets		—			0.8			1.2
Commodity contracts		Other assets		—			—			—

			$	0.4		$	0.8		$	1.4

Derivatives not designated as hedging instruments:
Foreign currency contracts		Other current assets		0.4			0.2			1.1

Total derivative assets			$	0.8		$	1.0		$	2.5


	Derivative liabilities
			Fair value
(in millions)	Balance sheet location		November 1, 2014			February 1, 2014			November 2, 2013
Derivatives designated as hedging instruments:
Foreign currency contracts		Other current liabilities	$	(0.3	)	$	(2.1	)	$	(0.7	)
Foreign currency contracts		Other liabilities		—			—			(0.2	)
Commodity contracts		Other current liabilities		(3.6	)		(0.8	)		(0.6	)
Commodity contracts		Other liabilities		—			—			—

			$	(3.9	)	$	(2.9	)	$	(1.5	)

Derivatives not designated as hedging instruments:
Foreign currency contracts		Other current liabilities		—			—			—

Total derivative liabilities			$	(3.9	)	$	(2.9	)	$	(1.5	)

Derivatives designated as cash flow hedges

The following table summarizes the pre-tax gains (losses) recorded in accumulated OCI for derivatives designated in cash flow hedging relationships:


(in millions)	November 1, 2014			February 1, 2014			November 2, 2013
Foreign currency contracts	$	(1.3	)	$	(2.3	)	$	—
Commodity contracts		(6.8	)⁽¹⁾		(18.8	)⁽¹⁾		(26.0	)⁽¹⁾

Total	$	(8.1	)	$	(21.1	)	$	(26.0	)

(1)	As of November 1, 2014, losses recorded in accumulated OCI include $3.6 million related to commodity contracts terminated prior to contract maturity in Fiscal 2014 (February 1, 2014 and November 2, 2013: $18.2 million and $25.9 million, respectively).

The following tables summarize the effect of derivative instruments designated as cash flow hedges in OCI and the condensed consolidated statements of operations:

Foreign currency contracts


			13 weeks ended						39 weeks ended
(in millions)	Statement of operations caption		November 1, 2014			November 2, 2013			November 1, 2014			November 2, 2013
(Losses) gains recorded in accumulated OCI, beginning of period			$	(3.2	)	$	2.3		$	(2.3	)	$	1.3
Current period gains (losses) recognized in OCI				1.6			(2.1	)		0.4			(0.7	)
Losses (gains) reclassified from accumulated OCI to net (loss) income		Cost of sales		0.3			(0.2	)		0.6			(0.6	)

(Losses) gains recorded in accumulated OCI, end of period			$	(1.3	)	$	—		$	(1.3	)	$	—

Commodity contracts


			13 weeks ended						39 weeks ended
(in millions)	Statement of operations caption		November 1, 2014			November 2, 2013			November 1, 2014			November 2, 2013
(Losses) gains recorded in accumulated OCI, beginning of period			$	(4.9	)	$	(28.6	)	$	(18.8	)	$	(0.5	)
Current period (losses) gains recognized in OCI				(4.3	)		0.3			(2.6	)		(27.2	)
Losses (gains) reclassified from accumulated OCI to net (loss) income		Cost of sales		2.4			2.3			14.6			1.7

(Losses) gains recorded in accumulated OCI, end of period			$	(6.8	)	$	(26.0	)	$	(6.8	)	$	(26.0	)

There was no material ineffectiveness related to the Company’s derivative instruments designated in cash flow hedging relationships during the 13 and 39 weeks ended November 1, 2014 and November 2, 2013, respectively. Based on current valuations, the Company expects approximately $5.8 million of net pre-tax derivative losses to be reclassified out of accumulated OCI into earnings within the next 12 months, of which $3.6 million will be recognized in the remaining three months of Fiscal 2015.

Derivatives not designated as hedging instruments

The following table presents the effects of the Company’s derivatives instruments not designated as cash flow hedges in the condensed consolidated statements of operations:


			13 weeks ended					39 weeks ended
(in millions)	Statement of operations caption		November 1, 2014		November 2, 2013			November 1, 2014		November 2, 2013
Derivatives not designated as hedging instruments:
Foreign currency contracts		Other operating income, net	$	2.0	$	(2.8	)	$	0.4	$	—

Total			$	2.0	$	(2.8	)	$	0.4	$	—

Fair value

The estimated fair value of Signet’s financial instruments held or issued to finance Signet’s operations is summarized below. Certain estimates and judgments were required to develop the fair value amounts. The fair value amounts shown below are not necessarily indicative of the amounts that Signet would realize upon disposition nor do they indicate Signet’s intent or ability to dispose of the financial instrument. Assets and liabilities that are carried at fair value are required to be classified and disclosed in one of the following three categories:

Level 1—quoted market prices in active markets for identical assets and liabilities

Level 2—observable market based inputs or unobservable inputs that are corroborated by market data

Level 3—unobservable inputs that are not corroborated by market data

Signet determines fair value based upon quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. The methods Signet uses to determine fair value on an instrument-specific basis are detailed below:


	November 1, 2014								February 1, 2014								November 2, 2013
(in millions)	Carrying Value			Quoted market prices for identical assets (Level 1)		Significant other observable inputs (Level 2)			Carrying Value			Quoted market prices for identical assets (Level 1)		Significant other observable inputs (Level 2)			Carrying Value			Quoted market prices for identical assets (Level 1)		Significant other observable inputs (Level 2)
Assets:
US Treasury securities	$	9.6		$	9.6	$	—		$	—		$	—	$	—		$	—		$	—	$	—
Corporate equity securities		3.3			3.3		—			—			—		—			—			—		—
Foreign currency contracts		0.8			—		0.8			0.2			—		0.2			1.3			—		1.3
Commodity contracts		—			—		—			0.8			—		0.8			1.2			—		1.2
US government agency securities		1.3			—		1.3			—			—		—			—			—		—
Corporate bonds and notes		9.3			—		9.3			—			—		—			—			—		—
Liabilities:
Foreign currency contracts		(0.3	)		—		(0.3	)		(2.1	)		—		(2.1	)		(0.9	)		—		(0.9	)
Commodity contracts		(3.6	)		—		(3.6	)		(0.8	)		—		(0.8	)		(0.6	)		—		(0.6	)

Investments in US Treasury securities and corporate equity securities are based on quoted market prices for identical instruments in active markets, and therefore were classified as a Level 1 measurement in the fair value hierarchy. Investments in US government agency securities and corporate bonds and notes are based on quoted prices for similar instruments in active markets, and therefore were classified as a Level 2 measurement in the fair value hierarchy. See Note 14 for additional information related to the Company’s available-for-sale investments. The fair value of derivative financial instruments has been determined based on market value equivalents at the balance sheet date, taking into account the current interest rate environment, foreign currency forward rates or commodity forward rates, and therefore were classified as a Level 2 measurement in the fair value hierarchy.

The carrying amounts of cash and cash equivalents, accounts receivable, other receivables, accounts payable and accrued liabilities approximate fair value because of the short-term maturity of these amounts.

The fair value of long-term debt was determined using quoted market prices in inactive markets or discounted cash flows based upon current borrowing rates and therefore were classified as a Level 2 measurement in the fair value hierarchy. See Note 19 – Loans, overdrafts and long-term debt for classification between current and long-term debt. The carrying amount and fair value of outstanding debt at were as follows:

November 1, 2014

February 1, 2014

November 2, 2013

(in millions)

Carrying
Value

Fair Value

Carrying
Value

Fair Value

Carrying
Value

Fair Value

Outstanding debt:

Senior notes (Level 2)

398.4

410.5

—

Securitization facility (Level 2)

600.0

—

Term loan (Level 2)

395.0

Capital lease obligations (Level 2)

1.5

—

Total outstanding debt

1,394.9

1,407.0

—